Chief Economist, India Ratings
The FY14 budget will be presented in the backdrop of the most uncertain global economic situation in recent times. Global growth has remained fragile and likely to remain so during most of 2013-14.
The fiscal cliff resolution in the US will have repercussions for the global economy. The Euro zone is expected to be stagnant next fiscal, other advanced economies are also likely to follow similar growth trends.
While, developing economies are expected to grow in FY14, their growth is likely to be lower than their peak growth performances of recent times. Global growth has significant impact on India's growth in general and manufacturing sectors in particular.
India is facing fiscal cliff of its own and India Ratings expects central government's fiscal deficit in FY13 to touch 5.8% of GDP (FY13 budget estimate: 5.1% and government's recent estimates of 5.3%). There is an urgent need to move back to the path of fiscal consolidation. While government acknowledges it, some difficult steps have to be taken to move back to fiscal consolidation path. Problem has to be solved both from revenue and expenditure side.
To increase revenue, steps should be taken to broaden tax base, mere increasing of tax rate will not solve the problem. Hiking tax rates will reduce compliance and give incentive to tax evasion. A low and stable tax regime is a necessary condition for improving the investment climate.
Inability to settle issues related to compensation for central sales tax (CST) is a major stumbling block for implementation of goods and services tax (GST), we expect budget to move towards agreement on CST and finally to implementation of GST. Twin deficit (fiscal and current account) is exerting pressure on growth of Indian economy.
Significant fiscal consolidation was achieved during FY04-FY08, which was revenue driven on the back of high economic growth. We expect budget to make the environment conducive to economic growth by improving investor's sentiments and capital inflows. While the direct investments are preferred mode of capital inflows, the portfolio inflow will have significant impact on exchange rate of Rupee.
India is a net commodity importer, exchange of rupee has a direct bearing on subsidy burden. While the dollar price of commodities is exogenous to India, strength of Rupee will provide comfort to subsidy payment.
On the expenditure front, subsidies should be targeted. A detailed roadmap to control fuel subsidy is the need of the hour. Middle and upper income sections of the society are major beneficiaries of fuel subsidy. While the best way to tackle fuel subsidy especially diesel subsidy would be to raise retail prices of diesel to eliminate subsidy.
The government could settle for second best alternative of increasing taxes on diesel vehicles, especially high end passenger cars. Government could go for a combination of gradual monthly increase in retail price and increase in taxes on diesel vehicles. The subsidy to poor section of the society should not be curtailed. Physical infrastructure — roads and power — has to improve. Road completion targets are missed repeatedly and coal issues is affecting power generation. Power deficit is associated with economic losses.
A government estimate in FY05 pegged economic losses due to power shortages at INR3,000bn. Improvement in physical infrastructure should be one focus point of budget. India has very poor record of human development and missed Millennium Development Goals.
Skill shortage is another inhibiting factor for adoption of modern technology and sustainable growth. While over the years government with the support of the World Bank is implementing Sarva Shiksha Abhiyan, which is yielding results, the higher education sector is in dire need of attention.
The private sector participation in education is limited due to not-for-profit status of sector. The budget should focus on this developmental aspect. Foreign university bill is pending with the parliament since last two years. Unless skills of population are not improved, we will not be able to reap the benefits of demographic dividend.
Movement of Indian economy to a high growth phase during FY04-FY08 was due to structural improvements — high savings and investment rate. Incrementally public sector contributed to a sizeable proportion of it. Since FY09, the savings rate started falling due to expansionary fiscal policies (higher deficit) and higher inflation also had an impact of household savings.
The budget should address this and adopt policies conducive to increasing the savings rate.
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